21◼ FINANCE Bloomberg Businessweek May 4, 2020managers—especiallythequantitativeinvestors
whocreatetradingrulesfromcomputermodels.
Asthebiggetbigger,a passivefundthattracksa
market-value index such as the S&P 500 gets to surf
that wave. Even a portfolio that buys all the S&P
stocks but holds them in equal proportion—instead
of concentrating in the very largest names as an
index fund does—is trailing the benchmark so far
this year, with a decline of around 17%.
The long-term evidence is already stacked against
active funds in general: Fewer than a quarter of
them have beaten their passive rivals over the past
decade, according to Morningstar. During the recent
bear market, only about 42% did so.
Quant managers, meanwhile, are naturally pulled
toward buying smaller companies. Instead of analyz-
ing a handful of companies in depth to assemble a
portfolio, quants sort through data to come up with
a few reliable trading signals and apply them across
thousands of securities. Since most companies are
midsize or small, quants can end up underweighted
in the blue chips that have lately been thumping the
rest of the market.
Los Angeles Capital Management, a money man-
ager that uses quantitative tools, has studied the
factors that guide its investing decisions—such as a
company’s forecast cash-flow growth or momentum
in its stock price—and found that applying them to
large companies reaped higher gains than with small
ones. In other words, the trading models haven’t
been working as well with the very stocks quants
are more likely to buy. “A lot of the factor efficacy
is just in those largest names, whereas historically
we used to think the factors apply across the mar-
ket,” says Edward Rackham, co-director of research.
The underperformance of small companies
shakes up one of the oldest quantitative investment
strategies in the books. A classic study by finance
professors Eugene Fama and Kenneth French
showed that stocks’ returns could be explained via
a variety of factors, including a size effect: Bet on
small stocks and against large ones, and you’ll come
out ahead. But in the first three months of 2020,
that strategy posted its worst period since at least
2002, extending a six-year decline, a Dow Jones
index shows.
Michael Hunstad, head of quantitative strategies
at Northern Trust Asset Management, says the size
factor isn’t dead. Rather, it just has a very long cycle,
meaning it can go into and out of favor for years at a
time. And not all quantitatively driven strategies are
suffering. For example, a hypothetical momentum
portfolio—one that buys the past year’s winners—has
outperformed through the 2020 sell-off.
Quants would refrain from making any qualitativepredictions, but it’s easy to see the pandemic con-
tinuingtoentrenchsomeadvantagesofsize.Bashing
BigTechnowlooksasdatedasa handshake,and
SiliconValley’sgiantsmaybeabletoexpandtheir
clout.Largecompaniescanalsofindit easiertotap
creditandsolvesupplychainproblems.
Evenso,GavinSmith,a fundmanageratasset
managementcompanyQMA,saysthegapbetween
bigandsmallhasbecomesostretchedthatsmall-
capsshouldseea recovery.Likewise,Hunstad
reckonsthemega-caps’ascendancymightnotlast
muchlonger,giventhesky-highexpectationsnow
pricedintotheirvaluations.Thatcouldgivequants
a break.If a handfulofgiantcompanies“havemas-
sivelyinflatedgrowthexpectations,andwe’rehead-
ingintoa recession,thosearegoingtobethenames
tofallthehardest,”Hunstadsays.�JustinaLeeTHE BOTTOM LINE The pandemic has only exacerbated the
long-standing performance gap between the S&P 500 and the rest
of the U.S. market.▼Changein stock index
sinceDec.31, 2019
S&P 500
Russell 2000ILLUSTRATION BY BAPTISTE VIROT. DATA: COMPILED BY BLOOMBERG
● Youhavetothinkaboutstocksdifferentlyata time
whenthenumbersalonedon’ttellyoumuchTheEmpty Earnings Season
This may be the least informative earnings season
in history. Companies’ first-quarter financial results
are scarcely relevant because they cover a period
that mostly predated the pandemic. About a fifth of
S&P 500 companies have stopped guiding Wall Street
analystsabouthowmuchtheyexpecttoearnthisyear.
Wildswingsinthemarketgivetheimpressionthat
stockpriceshavebecomeunanchored from reality.
Here’s the surprise, though. The lack of informa-
tion about the short-term situation may force inves-
tors to do what they should have been doing all
along, namely focus on companies’ long-term earn-
ings potential. Lazy expedients such as extrapolat-
ing the latest results into the future or leaning on the
forecasts of the chief financial officer aren’t working
right now. Stock prices are being influenced instead
by meaningful considerations: Is there a future for
cruise ships? Will we need less office space because
we’re staying home, or more because we’ll sit far-
ther apart? Will distancing create more demand for
cars and less for airlines?
These are bigger questions than the ones that
accompany an ordinary business cycle fluctuation.
“Investors have never had to make a decision like12/31/194/28/200%-20-40